Thursday, May 31, 2012

And in the perverse way my brain works I was thinking back to a 1987 show by Billy Bragg at the Coogee Bay Hotel and him singing Greetings to the New Brunette. (It is a song about a relationship with "Shirley".)

Due to the magic of YouTube I could find a live recording of the same song from the same tour (this time in Wellington New Zealand).

His argument comes down to the IPO discount being a cost of doing business.

However I would like to turn this into a real estate deal. I go to a real estate agent and ask her to sell my property at the best price.

I enter into a contract which obliges the real estate agent to sell at the best price.

She sells it at less than the best price - as she always does.

She has a queue of buyers willing to buy because she always sells at the best price.

In this case I would think she is a shonk more concerned with her own franchise (her queue of buyers) than my best price and her legal and moral obligations.

I think precisely that of investment bankers. Always have.

My view of the morality of this trade differs from TED's view. And I would like to explain how I think that TED has got to his strange position.

To do that I need to look at this transaction from Morgan Stanley's viewpoint

Morgan Stanley (at least on this deal) appear to have broken the cardinal rule of investment banking. The cardinal rule of investment banking is to look after the investment bank (in the hope that at bonus time they will look after you).

Morgan Stanley's interests are clearly damaged by the Facebook IPO. Their ability to do more IPOs of scale is somewhat limited. Their ability to do future deals is contingent on a reasonably predictable IPO discount.

In my post I defended Michael Grimes (the Morgan Stanley investment banker) as he did what the law and ethics required of him. He looked after the client. I stand by that moral assessment.

Michael Grimes should most certainly NOT be investigated by the SEC for this.

But here my deeply cynical side comes out: Michael Grimes should be fired by Morgan Stanley for this deal. He broke the cardinal rule of investment banking which is the investment bank's interests come before the client interests. By selling too much Facebook at too high a price he has damaged the franchise of the investment bank. That is untenable.

People get fired in investment banking for lesser infractions.

So where does the Epicurean Dealmaker's moral position come from

TED is an investment banker. His background is M&A.

Morality for him is defined by the cardinal rule of investment banking. After all that is what you have to do. It is the moral pact of everyone who works in investment banking.

Indeed it is a moral pact that almost all humans make. What feeds you becomes (in your eyes at least) moral.

This was the very point of my post. People's morality is defined not around what is right and just but what they need to do to make a buck. We are human. Even TED.

Investment bankers learn to rip of clients. That is what they need to do to get by.

And the Epicurean Dealmaker - and everyone else in the industry - has accepted that as the new fair and just.

Its not the Epicurean Dealmaker is a bad man. (I like and respect his blog. I think I would like and respect the man.) It is just that circumstances make the morals.

Tuesday, May 29, 2012

In an IPO an investment bank takes a fee from a business to place that stock in financial markets.

Or, more precisely, they take a fee from a business to sell part of that business.

Their customer is the company doing an IPO and they have a legal and moral obligation to get the highest price for the company they are selling. No more. No less.

However investment bankers have, as a practical matter, a desire to expand and improve their franchise. Their franchise consists of a huge number of buy-side investors (some retail, some institutional) who will buy from them whatever they sell so long as it comes in a prospectus.

Investment bankers expand that franchise by making sure the things sold in a prospectus have excess demand. If they can sell for $38 they chose to sell for $33 to guarantee a stag. Every time they do so they build their own franchise as an investment bank at a cost to the client to whom they owe a legal and moral duty and who is paying them fees.

The buy-side customers of investment banks have got used to playing in this little game of theft. We – as buy-siders – like to be able to buy IPOs and have instant stag profits. Indeed in the 1990s the game of giving favours to investment banks in exchange for instant stag profits became the way business was done on Wall Street.

The moral corruption of investment banks not only became accepted but we redefined morality around what investment banks did rather than what they should do. We though the process of systematically ripping off the sellers of IPOs in order to build the buy-side franchise of the investment bank was right-and-proper.

It is not right-and-proper and it never was right-and-proper.

The investment bank owes a duty to the seller of the IPO and that is all. Whining fools who complain otherwise have allowed their own greed to distort their morality until they have become gebbeths. Jeff Matthews argues it was their foolishness that cost them money. I disagree. The idea that Wall Street has an obligation to them (thus guaranteeing stag profits) cost them money. And that idea came from their complacent immorality - a complacent immorality pervasive on Wall Street.

But not only have people with hurt hip-pockets complained about the Facebook IPO their supplicants in the press have been sucked into supporting the buyers same self-interested immorality. The Wall Street Journal (a magazine captured by Wall Street not Silicon Valley) derides Michael Grimes (the Morgan Stanley Banker) for not standing up to David Ebersman (Facebook's CFO) and allowing Facebook to sell too many shares at too high a price. This is tits-up-backward. David Ebersman in this context is the client. He paid the fees. Michael Grimes had a duty to act in Ebersman's interest. Ebersman wanted to sell more shares at a higher price. Michael Grimes and Morgan Stanley obliged even at the cost to their own franchise.

And for that he is being pilloried in the press.

What we have here is an investment banker acting ethically. And the whole financial press is a twitter about it.

Saturday, May 26, 2012

There is - at least amongst North American grandmothers who are the natural buyers of American listed bank preferred securities - a love of yield.

Santander (the Spanish mega-bank) has preferred securities issued in America - they mostly replaced the preferred securities of Sovereign Bank - a Santander-owned US regional bank.

But they are equity securities of Santander - taking full equity risk for a high (but limited) yield.

Linked (here) is the Google Finance page for one such security. Par value is $25 and the last trade is $25.65 - a small premium to par.

What could possibly go wrong?

OK: plenty could go wrong - but we don't need to analyse whether the Spanish mega-banks will succeed or fail - all we need to do is observe how bizarre the pricing is. Why would you own this preferred when you could own the common? The ADR is trading at $5.66 - and good earnings (2009 would you believe) were $2.24 per ADR. The common is two and a bit times normalized earnings. The no-failure earnings yield on the common is 40 percent (and if it does not blow up you will get capital appreciation). The prefs are at 10 percent yield.

There is a good chance that Santander never again earns "normalized earnings". There is a crisis going on...

But go tell that to the preferred holders who are happy to take a very similar risk to the common for a 10 percent yield and no chance of capital appreciation. They must envisage a world where Santander is saved by equity dilution that somehow leaves them intact. After all they are presuming (through their holdings) that the preferred is more attractive than the common.

And they believe that just as the Spanish Government injects 24 billion euro into Bankia.

Thursday, May 24, 2012

As the previous posts have shown Gulfport Energy and Wexford Capital are related parties on many levels. All the major projects of Gulfport are essentially joint operations with Wexford or will be after proposed transactions.

Wexford holds this privileged position despite having sold down most of its shares.

A special committee of the Board of Directors consisting solely of independent directors negotiated and approved this transaction on behalf of Gulfport.

With all these related party transactions an independent director of Gulfport would really have their work cut out. The Chairman of Gulfport is - as shown - in many respects a Wexford man. Most the operations are on a day-to-day basis run by Wexford controlled entities. Gulfport has issued hundreds of millions of dollars in shares and invested the vast bulk of this money in Wexford controlled entities. Being an "independent director" of Gulfport would have to rank as one of the most involved directorships in corporate America.

So who are the independent directors. Lets crib this from Gulfport's website except that I am going to do it in reverse order because the directors start more colourful that way:

Craig Groeschel: Director

Mr. Groeschel has served as a director of our company since August 2011. Since 1996, Mr. Groeschel has served as a founding pastor of LifeChurch.tv, one of the largest churches in the United States, reaching over 30,000 people each weekend. Since founding LifeChurch, Mr. Groeschel has served on its Board of Directors. Under Mr. Groeschel’s leadership, LifeChurch has grown to 15 locations in the United States. Mr. Groeschel received a Bachelors in Business Marketing from the Oklahoma City University and a Masters of Divinity from the Phillips Graduate Seminary. Mr. Groeschel is a frequent speaker at various domestic and international forums and an author of a number of books.

Craig Groeschel is a very high profile pastor - running a church reaching over 30 thousand people each weekend. He hangs around with Brian Houston from the Hillsong Church in my home town (Sydney Australia). Hillsong was founded by (now deceased) paedophile priest Frank Houston. Frank was sacked by his Brian who now runs the show. [OK - I am a self-described godless liberal from Sydney. I have learned to loathe Hillsong and all that it stands for. My intense dislike of Hillsong might colour my judgement...]

Whatever: Craig Groeschel's church is nowhere near as controversial as Hillsong but it is easier to find tithing demands than charitable works on the internet. Here is one:

Independence is an issue with Pastor Groeschel. In a 2007 prospectus (withdrawn) for Diamond Back Energy Services Pastor Groeschel agreed to be a director. Do I need to say that Gulfport was a Wexford entity?

This Pastor is an independent director of Gulfport who negotiated a sale of the majority of Gulfport's oil reserves to a Wexford controlled entity called Diamondback. He was once slated as a director of a Wexford controlled entity called Diamondback.

Still he is independent now...

The next director is Donald L. Dillingham. Here is his CV cribbed from the website.

Mr. Dillingham has served as a director of our company since November 2007. Since August 2001, Mr. Dillingham has served as the Senior Portfolio Manager for Avondale Investments, LLC and Merit Advisors, Inc., each of which is a registered investment advisor. Mr. Dillingham is currently the Senior Portfolio Manager for two mutual funds, a member of the investment committee of Merit Advisors, Inc. and the Vice-President/Treasurer of the Merit Advisors Investment Trust. From August 2002 to December 2004, Mr. Dillingham served as an adjunct professor of finance at the University of Oklahoma. Mr. Dillingham has also served as Senior Vice President, portfolio manager and state director for J.P. Morgan Investment Management, State Director responsible for managing the financial planning services and product sales for the State of Oklahoma for American Express, and Vice-President of Investment Banking for Bank of America. Mr. Dillingham began his career in the finance industry with Stifel, Nicolaus as a fixed income analyst, risked based market maker and sales manager from August 1984 to May 1994. Mr. Dillingham received a Bachelors of Business and Administration in Accounting from the University of Oklahoma and his Masters of Business and Administration in Finance from Oklahoma City University. Mr. Dillingham is a Chartered Financial Analyst, a Certified Public Accountant and a Certified Financial Planner. Mr. Dillingham is considered an independent director.

I have not checked the veracity of this CV however there are a few things missing. Donald Dillingham is also a director of The Beard Company. This now trades on the pink sheets under the ticker BRCO. The Beard Company had quite good looking assets and "proven" oil reserves but still managed to run out of cash. It never went bust though - it just went quiet. It no longer files with the SEC.

He has also been involved in a tax case with some controversy. The website (with his CV) for what he appears to be his main business is here.

The next director is Scott E. Streller. Here is his CV.

Mr. Streller has served as a director of the company since August 2006. Mr. Streller is the principal and founder of Streller Insurance and Financial Services with the Farmers Insurance Group of companies. Mr. Streller’s agency is consistently recognized as one the top agencies in the nation and is a member of the elite President’s Council. Mr. Streller is a frequent guest lecturer to Oklahoma City based universities and high schools on the topics of finance, risk management and budgeting. Mr. Streller is a member of numerous non-profit boards and recently served as the operations director for the 2006 Senior PGA Championship. Mr. Streller received a bachelor’s degree in business administration from the University of Central Oklahoma and a master’s degree in athletic administration from Oklahoma State University. Mr. Streller is considered an independent director.

A tied insurance agent does not strike me as the obvious choice for such a difficult independent directorship. Whatever my problem is not with him being an insurance agent. It is with the assertion that Mr Streller is an "independent director". Gulfport discloses otherwise in the 2007 proxy. To quote:

Effective September 29, 2006, we entered into an administrative services agreement with Diamondback Energy Services LLC, which we refer to as Diamondback. Under the agreement, our services for Diamondback include accounting, human resources, legal and technical support. The services provided to Diamondback and the fees for such services can be amended by mutual agreement of the parties. The administrative services agreement has a three-year term, and upon expiration of that term the agreement will continue on a month-to-month basis until cancelled by either party with at least 30 days prior written notice. The administrative services agreement is terminable (1) by Diamondback at any time with at least 30 days prior written notice to us and (2) by either party if the other party is in material breach and such breach has not been cured within 30 days of receipt of written notice of such breach. We were reimbursed approximately $823,000 for services provided under this agreement during the year ended December 31, 2006. Our Chairman of the Board, Mike Liddell, is also the Chairman of the Board of Diamondback. One of our directors, Scott Streller, is also a director nominee of Diamondback. In addition, Wexford Capital LLC indirectly controls Diamondback.

I thought the Good Pastor was compromised having once agreed to be a director of Diamondback. But this is kind of special. Scott Streller is an independent director for the purposes of selling the Permian assets (that is the bulk of the proved oil reserves) to a Wexford controlled entity called Diamondback.

But in 2006-2007 he was director of a Wexford backed entity called Diamondback. The Pastor only agreed to be a director of the Diamondback entity.

The last independent director is David L. Houston. Here is his CV:

Mr. Houston has served as a director of the company since July 1998. Since 1991, Mr. Houston has been the principal of Houston & Associates, a firm that offers life and disability insurance, compensation and benefits plans and estate planning. Mr. Houston has served as a director of Bronco Drilling Company since May 2005. Mr. Houston was President and Chief Executive Officer of Equity Bank for Savings, F.A., an Oklahoma-based savings bank. Mr. Houston currently serves on the board of directors and executive committee of Deaconess Hospital, Oklahoma City, Oklahoma, and is the former chair of the Oklahoma State Ethics Commission and the Oklahoma League of Savings Institutions. Mr. Houston received a Bachelor of Science degree in business from Oklahoma State University and a graduate degree in banking from Louisiana State University. Mr. Houston is considered an independent director.

So there they are. The four independent directors of a company laced with related party transactions - possibly the four independent directors with the hardest job (assessing all those transactions) of any oil and gas company I know.

Still - and I should repeat this - the company has set up a "special committee of the Board of Directors consisting solely of independent directors" to negotiate and approve the major transactions on behalf of Gulfport. And that is good practice.

Wednesday, May 23, 2012

From the last 10Q here are Gulfport Energy's revenue numbers for the past three months:

Three Months Ended March 31,

2012

2011

Revenues:

Oil and condensate sales

$

64,004,000

$

45,196,000

Gas sales

613,000

720,000

Natural gas liquids sales

806,000

659,000

Other income

38,000

63,000

65,461,000

46,638,000

They had $65 million in revenue.

Net income was $26.7 million dollars.

Here is the cash flow statement for operating cash flows:

Three Months Ended March 31,

2012

2011

Cash flows from operating activities:

Net income

$

26,869,000

$

21,174,000

Adjustments to reconcile net income to net cash provided by operating activities:

Accretion of discount - Asset Retirement Obligation

176,000

159,000

Depletion, depreciation and amortization

21,395,000

12,158,000

Stock-based compensation expense

681,000

77,000

Loss from equity investments

268,000

316,000

Interest income - note receivable

—

(36,000

)

Unrealized loss on derivative instruments

266,000

—

Amortization of loan commitment fees

112,000

110,000

Changes in operating assets and liabilities:

Increase in accounts receivable

(1,718,000

)

(5,419,000

)

Increase in accounts receivable - related party

(463,000

)

(160,000

)

(Increase) decrease in prepaid expenses

(57,000

)

618,000

Increase (decrease) in accounts payable and accrued liabilities

22,431,000

(709,000

)

Settlement of asset retirement obligation

(531,000

)

—

Net cash provided by operating activities

69,429,000

28,288,000

The cash generated was - believe it or not - slightly larger than the revenue - and over 40 million higher than profits. Part of that was depletion (depreciation adds to cash flow). Most the rest was simply an increase in accounts payable of 22 million.

Here is the cash flow from investing for that three months:

Cash flows from investing activities:

Additions to other property, plant and equipment

(82,000

)

(13,000

)

Additions to oil and gas properties

(84,778,000

)

(33,285,000

)

Proceeds from sale of other property, plant and equipment

140,000

—

Proceeds from sale of oil and gas properties

—

1,384,000

Advances on note receivable to related party

—

(1,319,000

)

Contributions to investment in Grizzly Oil Sands ULC

(67,063,000

)

(4,878,000

)

Distributions from investment in Tatex Thailand II, LLC

200,000

—

Contributions to investment in Tatex Thailand III, LLC

(483,000

)

(895,000

)

Contributions to investment in Muskie Holdings LLC

(312,000

)

—

Contributions to investment in Timber Wolf Terminals LLC

(1,000,000

)

—

Contributions to investment in Windsor Midstream LLC

(7,021,000

)

—

Net cash used in investing activities

(160,399,000

)

(39,006,000

)

In those three months they invested $160 million but only had cash flows of $69 million and earnings of $26.7 million.

How did they finance this?

As noted the company had to finance $160 million of investing activities from only $26.7 million in operating earnings. This presents financing issues.

Firstly the company (as noted) ran up its accrued liabilities.

Then the company borrowed $10 million dollars.

But mostly the company ran down its cash holdings from $93 million to $13 million.

Where did those cash holdings come from?

The cash holdings did not represent past profits. What they were was proceeds from equity issuance. The company cash flow statement in 2011 shows $307 million in equity issuance - much of which has gone into investing in various quarters. The cash is now heavily depleted (note only $13 million is left).

If they intend on investing at these rates they will need to raise more capital.

What were the investments?

In the last quarter they invested $67 million in Grizzly Oil Sands. That is controlled by Wexford.

They also invested in Tatex, Muskie, Timberwolf and Windsor. All of these are Wexford entities.

Indeed they invested more than their entire revenue in Wexford Entities.

But they also added $85 million to oil and gas properties. A fair bit of that was with respect to the Permian Basin properties (they drilled wells and acquired acreage). Those assets are also being sold to a Wexford controlled entity. Other releases have envisaged a sale of that entity which will raise some cash allowing them to continue to invest.

Tuesday, May 22, 2012

In the last post I demonstrated that 12.885 million out of 19.367 million barrels of oil equivalent (BOE) in "proved reserves" was being sold by Gulfport to a related party of Wexford. These were the Permian Basin fields as per the table below.

Given that most the reserves and most the cash flows of Gulfport are being sold to a related party it is worth considering the quality of the assets left. After all - if you are a Gulfport shareholder that is what you are buying.

Lets just take the Niobrara acreage.

The claim of half a million barrels of oil in the Niobrara raised my eyebrows because I thought most that acreage was locked up. Indeed it was this claim that attracted me (as a short) to Gulfport in the first place. I wanted to see what they based their claim of half a million barrels of proved oil on.

Here is what the 10K says about the Niobrara acreage:

Location and Land

Effective as of April 1, 2010, we acquired leasehold interests in the Niobrara Formation in northwestern Colorado, and held leases for 14,993 acres as of December 31, 2011. We are the operator on the acreage.

Area History

The Niobrara Formation is a shale oil rock formation located in Colorado, Northwest Kansas, Southwest Nebraska, and Southeast Wyoming. Oil and natural gas can be found at depths of 3,000 to 14,000 feet and is drilled both vertically and horizontally. The Upper Cretaceous Niobrara formation has emerged as another potential crude oil resource play in various basins throughout the northern Rocky Mountain region. As with most resource plays, the Niobrara has a history of producing through conventional technology with some of the earliest production dating back to the early 1900s. Natural fracturing has played a key role in producing the Niobrara historically due to the low porosity and low permeability of the formation. Because of this, conventional production has been very localized and limited in area extent. We believe the Niobrara can be produced on a more widespread basis using today’s horizontal multi-stage fracture stimulation technology where the Niobrara is thermally mature.

Geology

The Niobrara Formation oil play in northwestern Colorado is located between the Piceance Basin to the south and the Sand Wash Basin to the north. Rocks mainly consist of interbedded organic-rich shales, calcareous shales and marlstones. It is the fractured marlstone intervals locally known as the Buck Peak, Tow Creek and Wolf Mountain benches that account for the majority of the areas production. These fractured carbonate reservoirs are associated with anticlinal, synclinal and monoclinal folds, and fault zones. This proven oil accumulation is considered to be continuous in nature and lightly explored. Source rocks are predominantly oil prone and thermally mature with respect oil generation. The producing intervals are geologically equivalent to the Niobrara reservoirs of the DJ and Powder River Basins which are currently emerging as a major crude resource play.

Production Status

In the fourth quarter of 2011, our net production from our Niobrara acreage was 3,390 BOE, or an average of 37 BOE per day, 100% of which was from oil. From January 1, 2012 through January 31, 2012, our average daily net production from our Niobrara acreage was 41 BOE, 100% of which was from oil.

Facilities

There are typical land oil and gas processing facilities in the Niobrara Formation. Our facilities located at well locations include storage tank batteries, oil/gas/water separation equipment and pumping units.

Recent and Future Activity

We drilled three gross (1.5 net) wells at Niobrara during 2011. We have completed a 60 square mile 3-D seismic survey over our Craig Dome prospect, have received a processed version of the seismic and are selecting future drilling locations. We currently intend to drill five to seven gross wells at Niobrara during 2012.

Production - net - was 37 barrels of oil per day during the fourth quarter of 2011. In January they raised this to 41 barrels of oil per day.

The most recent 10Q filing contains this text.

Niobrara Formation. Effective as of April 1, 2010, we acquired leasehold interests in the Niobrara formation in Colorado and held leases for approximately 14,993 acres as of March 31, 2012. Aggregate net production from the Niobrara play during the three months ended March 31, 2012 was approximately 2,638 BOE, or 29 BOE per day. During April 2012, average daily net production in Niobrara was approximately 66 BOE due to completion of our 2011 drilling activity.

So for the first quarter the production fell to average only 29 BOE per day after averaging 41 BOE per day in January.

41 BOE per day in January implies production of 1271 barrels (approx) in January (being 41 BOE per day times 31 days).

We are told that production in the quarter was 2638 barrels. Simple arithmetic implies that production in February and March was 1367 BOE. Assuming 60 days in those months (29 in February, 31 in March) we get production of 22.8 barrels per day. A fairly sharp drop from 41 BOE per day in January. This may be a decline rate or it may be weather or other shut-in (we do not know). However shut-ins are more likely in January so decline is a reasonable guess.

After completing drilling activity for 2011 the production rose to 66 BOE per day.

These are not big numbers and production drops seem large. Indeed flow rates almost halved within the first quarter.

However the company states that 500 thousand barrels of oil in reserves are proven in this field.

It is a cliché that you only know what the reserves of an oil field were when the last barrel is produced. There are many fields that have surprised to the downside and some that have surprised to the upside.

I will leave it to my readers to judge - whether on the basis of the relatively small production and high decline rates demonstrated - they regard the 500 thousand barrels of proved reserves listed here as a solid number.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.